Budget forecasts: the impact of lower GDP growth

Alongside Autumn Budget 2017, the Office for Budget Responsibility (OBR) published updated forecasts for the economy and public finances. These are the official forecasts used by the Chancellor in the Budget.

The OBR now forecasts lower economic growth, compared with their March 2017 forecast. Here we explain why and discuss the impact on incomes and government borrowing.

Large reduction in productivity forecasts…

The big change in the OBR’s forecasts was its downgrading of its productivity growth expectations for the next five years, something they had previously warned they would do. Productivity growth is crucial for sustained economic growth and for rising living standards. In the decades prior to the 2008/09 recession, it had grown by around 2% a year; since then it has barely grown at all.

The OBR had previously expected that productivity growth would eventually bounce back to its 2% historical average. Time and time again productivity growth was lower than the OBR – and others – had forecast. The OBR has now determined that productivity growth has “shown little signs of recovering” and that this “the recent weakness will indeed prove more enduring” than previously thought.

The result is annual productivity growth being lowered by around 0.6 percentage points on average starting from next year. For example, in 2020 it has been lowered from 1.8% previously to 1.2% now.

…have lowered GDP growth forecasts…

The knock-on effects of lower productivity growth forecasts were significant. For instance, the OBR lowered its GDP growth forecasts every year as a result. Changes in productivity are an important factor in determining growth rates, along with the number of hours worked overall in the economy (forecasts for which were raised).

GDP growth is now forecast to average 1.4% every year for the period 2018-2021 compared with the 1.8% average in the OBR’s previous March 2017 forecast.

….and household income forecasts…

Lower productivity growth also has implications for the OBR’s projections for wage growth – they said that they “expect lower productivity growth to be reflected in weaker earnings growth”. Overall household incomes – which include wages plus other income, such as social security payments – are also impacted.

The OBR’s new forecasts for total after-tax income of all households in the economy, adjusted for inflation, on a per head basis – a measure of average household income – is now expected to be 0.2% lower in 2021 compared to 2016. In March 2017 the OBR had forecast an increase of 2.0% over the same period.

…and increased government borrowing.

The OBR has increased its forecast for government borrowing – sometimes referred to as the deficit – in the later years of the forecast. Revisions relating to changes in the economic forecast – most notably the lower productivity growth – play a significant role in the increase.

The OBR’s revision to productivity weakens the outlook for GDP growth, which in turn lowers the forecast for taxes and raises borrowing. By 2021/22, the OBR’s productivity revision adds around £26 billion to borrowing.

Positive improvements to the OBR’s assumptions about elements of the labour market offset some of the additional productivity-related borrowing. The OBR now think that the UK economy can sustain a lower unemployment rate without upward wage pressure. This raises GDP growth, and reduces borrowing by around £3 billion in 2021/22. The OBR also now assume that average hours worked will remain broadly flat, rather than falling as they previously expected. This raises GDP growth, and reduces borrowing by around £7 billion in 2021/22.

 

Other items, some of which are unrelated to productivity or the GDP forecast, also impact on the OBR’s borrowing forecast:

  • Other forecast revisions, such as the OBR using more recent population projections from the Office for National Statistics, increase borrowing by around £2 billion in 2021/22. These group of revisions lower borrowing in earlier years.
  • Classification changes, such as English housing associations moving out of the public sector, reduce borrowing by around £6 billion in 2021/22. See our previous blog for more detail on this issue.
  • The tax and spending decisions taken by the Government in the Budget increase borrowing by £1.5 billion in 2021/22. Government decisions increase borrowing by around £9 billion in 2019/20.

Taken all together, these changes mean that the OBR forecasts that borrowing in 2021/22 will be around £13 billion higher in 2021/22 than they thought in March 2017.

 

Picture credit: Autumn colours at Westminster by Manish Prabhune.  Licensed by CC BY 2.0 / image cropped